Speech
Opening Statement to the House of Representatives Standing Committee on Economics

Since the Committee's previous meeting in September,
we have continued to see evidence that economic activity
outside the resources sector has been gradually improving.
The pattern observed six months ago whereby business
surveys were suggesting improving conditions by and
large continued through to the end of the year.

Inevitably, this expansion is not uniform across the
country or across industries. Areas that led the growth
dynamic a few years ago are on the trailing edge now.
Conversely, some that were subdued for a few years are
among those leading growth today.

But few, if any, expansions are completely even, either
geographically or by industry. Given the nature of the
economic events through which we have been living, moreover,
it is not surprising that there are differences. The
good thing is that there are strong areas to counteract
the weak ones.

The available information suggests that real GDP is
expanding at pace a bit lower than what we used to think
of as normal. Our estimate is that growth over the four
quarters of 2015 was about 2½ per cent. This continued
expansion has occurred in the face of a very large contraction
in capital spending in the mining sector, restrained
public final spending and the reduction in national
income coming from the declining terms of trade. It
has been helped by easy monetary policy and the lower
exchange rate.

Notwithstanding below-average GDP growth, the demand
for labour increased at an above average pace in 2015.
The number of people employed, as measured, increased
by well over 2 per cent, participation in the labour
force picked up and the rate of unemployment declined,
to be below 6 per cent. That is a noticeably better
outcome than we expected a year ago.

This poses the obvious question of how, with apparently
still somewhat below-trend GDP growth, the rate of unemployment
has fallen. And whether the pattern will continue. Of
course, it may be that the labour force data overstate
the strength. Alternatively they may be telling us something
not yet apparent in the GDP estimates. More data may
shed light on this question over time.

Part of the reconciliation appears to be that growth
has been concentrated somewhat in labour-intensive areas,
like certain household and business services.

Another part of the reconciliation probably lies in
the very modest pace of growth of labour costs. At any
given rate of unemployment, wages growth appears to
have been lower than would have been expected based
on historical relationships. In fact, at an economy-wide
level, unit labour costs – that is, wages per
unit of aggregate output – have not risen for
four years. This has surely helped employment.

This same phenomenon is also important in understanding
the behaviour of inflation, which has been quite low.
As measured by the Consumer Price Index, inflation was
1.7 per cent over 2015. This was affected by falling
prices for petrol and utilities, the latter in part
due to government policy decisions. But even the underlying
measures, which remove or down‑weight such effects,
at around 2 per cent, are low. Price rises for non-tradeable
items are at their lowest for many years, and this reflects,
among other things, the modest growth of labour costs.

In summary then, the economy is continuing to grow at
a modest pace, in the face of considerable adjustment
challenges. It has apparently been generating more employment
growth and lower unemployment than we expected, while
inflation has remained quite low.

Turning then to the rest of the world, there have been
some key developments since we last met with the Committee.

In December, the United States Federal Reserve raised
its policy interest rate for the first time in 9½ years.
The last time the Fed actually started an upward phase
in rates was as far back as 2004. The Fed's rationale
for this change was that the US economy had sufficient
strength that a zero interest rate was no longer needed
– and, as such, it is a welcome development. The
change had been very well telegraphed and was absorbed
by financial markets without any immediate disruption.

That said, US dollar funding costs are important to
many financial strategies around the world and when
they start to increase, however gradually, investors
adjust their positions. This had already been happening
in anticipation of the Fed's decision, with funds
seeking to lessen their exposures to emerging markets,
high-yield debt instruments and so on.

These adjustments continued subsequent to the Fed announcement.
For some emerging market economies, facing lower commodity
export prices, things have become more challenging.

At the same time, some other major jurisdictions have
sought to ease their monetary policies further. Both
the European Central Bank and the Bank of Japan have
pushed rates on some deposits at the central bank below
zero. In other words, policy trajectories among the
major jurisdictions are diverging, which creates the
potential for market movements, not least in exchange
rates.

Meanwhile, the Chinese economy has become more of a
concern for many observers. It is not that the actual
data on the Chinese economy are all that different from
what we had been seeing. They paint a picture of softness
in growth – but they were already saying that
some time ago. The more recent anxiety is probably best
described as greater uncertainty over the intentions
of Chinese policymakers and over whether they will be
able to carry off the economic transition China needs.
This anxiety has been reflected in capital flows.

Commodity prices have generally fallen further over
recent months. Most prominent was the further fall in
crude oil prices to about US$30 per barrel. While this
level of oil prices is not especially low in a longer-run
historical context, it is a large decline from prices
prevailing in recent years and is bringing considerable
adjustment. Oil-producing companies and nations are
seeing a decline in their incomes, and yields on debt
issued by corporates in the energy sector have increased
sharply. Exploration expenditure and investment in new
capacity is being rapidly curtailed. Sovereign asset
managers for some key oil producers are liquidating
some assets to help manage the effects on fiscal positions.

As with most price changes, there are gainers as well
as losers. The fall in energy costs is a windfall to
energy users and represents a terms of trade gain for
countries that are net importers. Importantly, it does
not appear to be the case that the fall has predominantly
been caused by weak demand for oil. Indications are
that oil demand has still been rising, albeit not as
quickly as it had been. Supply increases appear to have
been more important than demand factors in explaining
the large price fall, at least thus far. Hence, we should
not interpret the decline in oil prices as uniformly
negative. On the contrary, a fall in oil prices resulting
from additional supply has usually been seen clearly
as a bonus for consumers and many businesses in advanced
economies, including Australia.

In financial markets, as investors and traders have
sought to make sense of all these conflicting currents,
we have seen a period of volatility recently. This has
been apparent in equity and bond markets, as well as
foreign exchange markets. Equity markets are lower,
yields for core sovereign obligations are lower, spreads
for lower-rated corporates and emerging market sovereigns
are wider. Exchange rates have seen more variability,
with currencies for many emerging market countries weaker.
The Australian dollar is around the same level now as
when we last met with the Committee, though commodity
prices are lower.

Looking ahead, forecasters expect a bit less growth
in the global economy this year than they did a few
months ago. Expectations for Australia's trading
partner group itself are for growth to be a bit below
average, little changed from six months ago. Inflationary
pressures globally look quite subdued. Global interest
rates will still be very low, even if short-term rates
move up a bit further in the United States.

For Australia, the adjustment we have been experiencing
for a couple of years now will most likely continue.
The terms of trade are still falling. The fall in mining
investment spending will continue for at least one more
year, though it is probably having its most significant
effect on the rate of growth now. Other areas of demand
are expected to add to growth. The net effect of all
this is likely to be continuing expansion at a moderate
pace.

One key question will be whether the recent financial
turbulence itself will have a material negative effect
on aggregate demand – in Australia or abroad.
I don't expect that we will be able to answer
that question for a little while yet.

Another question is what the recent unexpected strength
in the labour market means for the outlook. If it turns
out that the strength is just temporary, then the outlook
is still for moderate growth, but no near-term acceleration.
If, on the other hand, recent trends were to continue,
the income gains coming from higher employment may start
to feed into stronger demand growth, which would probably
lead in due course to higher levels of investment. Alternatively,
if demand growth were to be in areas that require relatively
little capital to support the labour employed, then
the apparent weakness in capital spending outside mining
could be of less concern anyway.

As usual, there are many questions regarding both our
current circumstances and the outlook. At its recent
meetings, the Reserve Bank Board has kept the stance
of policy unchanged, with the cash rate at 2.0 per cent.
We will be examining new information over the months
ahead as we try to discern the answers to these and
other questions. With inflation unlikely to cause a
problem by being too high over the next year or two,
the statement after the recent meeting indicated that
the Board retains the flexibility to ease further, should
that be helpful.